Consolidation makes online security firms insecure

[William Knowles <wk () C4I ORG>]

http://www.herring.com/investor/2000/0831/inv-security083100.html

By Lisa Meyer
Redherring.com, August 31, 2000

Baltimore Technologies (Nasdaq: BALT), an Ireland-based Internet
security firm, was quick to deny rumors Tuesday that U.S computer
giant Microsoft (Nasdaq: MSFT) was considering a takeover bid. But
like many rumors, this one revealed certain truths. In this case, the
gossip shed light on the hustle to establish a standard in the online
security industry, one of the fastest growth areas of the Internet.

Security for Net transactions is becoming more important. Recent
studies have shown that concerns about online security are undermining
the trust between companies and trading partners, as well as between
online retailers and consumers. Moreover, laws recently passed in both
the U.S. and Europe that render electronic signatures in online
contracts legally enforceable increase the demand.

"The marketplace is forcing a solution," says Peter Sealey, professor
at the Haas School of Business at the University of California,
Berkeley. "What companies that deal in online security are discovering
is that they need a robust solution. Some niche players may survive.
But the industry needs a standard. The winner who establishes that
standard will control half the market."

CONSOLIDATION COMING
To that end, many of the hundred or so players are consolidating in an
attempt to expand their portfolios of online security options. Small
players are merging with each other, while bigger companies are
swallowing their inferiors. Even software and system management
vendors are entering the online security market by buying niche
companies in order to bring online security in-house.

Currently, there are dozens of specialist Internet security companies,
including Baltimore Technologies and Entrust (Nasdaq: ENTU). Big tech
players like Cisco Systems, Novell, Nortel Networks, IBM, and
Hewlett-Packard also offer security products and services as part of
an overall package. To add to that, companies like Logica and Andersen
Consulting offer security services such as consulting and systems
integration.

"There is a broad universe of online security companies, and a lot of
them are complementary and make good acquisition partners," explains
David Hilal, analyst at Friedman, Billings, Ramsey. As an example, Mr.
Hilal cites the recent acquisition of Axent Technologies (Nasdaq:
AXNT), a provider of e-security solutions, by competitor Symantec
(Nasdaq: SYMC). Since little overlap exists between the two companies,
their merger widens the reach of each. "Symantec is more
consumer-oriented and is one of the leaders in antiviral technology,
whereas Axent is more enterprise-focused," Mr. Hilal says. According
to him, the winner in this industry will be the company that offers
the most solutions. Since a hacker's ability to attack companies is
increasing as quickly as technology is advancing, "vendors that offer
the broadest solution will win," Mr. Hilal says. "Companies can't just
target one problem."

Other analysts believe that niche companies can achieve a standard by
leveraging their core products across various platforms.

VERISIGN DOMINATES THE MARKET
Choosing the broad-based solution strategy, Verisign (Nasdaq: VRSN) is
by far the current leader in online security. The company has a $37
billion market capitalization, which far exceeds the market
capitalization of competitors Baltimore Technologies, with $4.3
billion, and Entrust, with $1.6 billion.

Verisign has a far more diversified product line than these smaller
companies. Its strategy is to provide a broad online-commerce
solution, including not only security, but also payment and Web site
solutions. Recent acquisitions of Signio, an Internet payment
platform, and Network Solutions, a provider of domain-name
infrastructure and registration services, pushed Verisign into a wider
market.

The company's core business, however, is authentication services,
which include digital certificate and managed public-key
infrastructure (PKI) services. Such services encrypt data that can be
sent through cyberspace, while also providing the receiver with a key
to unlock it.

In its second quarter filings with the Securities and Exchange
Commission, Verisign reported sales of 64,000 digital certificates, or
a 137 percent increase from the same period last year, and 200 new
customers, including BP Amoco and Reuters.

Verisign also has increased its reach internationally, by recently
adding five affiliates: Telefonica in Spain, Bigon in Poland, Comsign
in Israel, Cybersign in Malaysia, and IT Trust in Egypt. Aggressively
entering the burgeoning broadband and wireless markets, Verisign
recently introduced new technologies that will allow its customers to
access private information and execute secure transactions from
virtually any Internet-enabled device.

"Verisign has chosen an outsource model," says Mark Fernandes, an
analyst at Merrill Lynch. "They have a large data center and pulled in
different services. Because of this business model, the company can
add a lot of functionality."

SMALLER FISH TRY NOT TO GET SWALLOWED
In order to keep their customers from going to competitors who offer a
broader range of online security services, Baltimore Technologies and
Entrust have made acquisitions recently to broaden their portfolios,
while maintaining a strong focus on their core product, PKI. They are
mimicking Verisign, but on a smaller scale.

Baltimore Technologies strengthened its U.S. and international
presence through its acquisitions of GTE Cyber Trust Solutions, a PKI
provider, and Japanese online security provider NSJ Corporation.
Baltimore Technologies also has partnerships with Andersen Consulting,
Compaq, Hewlett-Packard, Sony, EDS, and Unisys. The company reported
revenue of $24.6 million in the second quarter, a 72 percent increase
from the first quarter and a 221 percent gain from the second quarter
of 1999.

Although Baltimore Technologies is expected to lose money this year
and in 2001, its revenues are growing much faster than those of its
major competitor, Entrust, which has struggled since warning in July
that second quarter earnings would be much lower than expected.
Entrust reported flat revenue growth in the second quarter as compared
to the first quarter, and a 48 percent increase in revenue from the
first quarter of 1999.

The main difference between Baltimore Technologies's current success
and Entrust's recent woes is execution. Both companies are expanding
in the international and wireless arenas. But Baltimore Technologies
is a smaller company than Entrust in terms of sales in PKI. The former
only sells security systems when a company is ready for a full
deployment of an application, whereas Entrust gains customers through
pilots, counting on a certain number of those clients to migrate to
larger implementations. This quarter, however, Entrust didn't see
enough of those migrations.

"Even if Baltimore's growth slows down, they won't be affected as
acutely as Entrust," explains Howard Smith, analyst at First Analysis.
"When you go off a smaller base, it's easier to hit the number."

A number of class-action suits also dog Entrust. One alleges that
Entrust's representations on second-quarter earnings artificially
inflated the price of its stock, which in turn enabled the company to
complete its acquisition of enCommerce, a Web security software
company that provides authentication for selective access control to
intranet/extranet Web-enabled resources.

"Entrust is one of the companies today that has a very specialized
solution and has yet to broaden its portfolio," says Mr. Hilal. "It's
ripe for acquisition."

But most analysts return to Verisign when recommending a solid
long-term investment opportunity, even though much of the optimism is
already factored in the stock price.

"Verisign is the highest quality company," says Mr. Howard. "But
today's valuation reflects a lot of positive sentiment and not the
risks inherent in technology over the next few years."

That may be true. But the beauty of having such a richly valued stock
is that companies can easily use the shares to buy other companies. So
look for Verisign to keep making purchases in order to solidify its
leadership position in what is still a fragmented market.


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